Rule Breaker Portfolio

Fool Portfolio Report
Thursday, December 18, 1997
by Jeff Fischer (TMFJeff@aol.com)


ALEXANDRIA, VA (Dec. 18, 1997) -- It's that time of year when you'd like to see things slow down, cool off, go quiet -- so that you can relax, put your feet up, and exhale... before drifting into a light sleep.

Well, no such luck for us today!

A barrage of news and a volatile stock market demand comment. The S&P lost 1% while the Nasdaq continued its weakness, falling another 1.5%, and now down 4.8% for the month (so much for the "Santa Claus rally"). The Fool fared worse, dropping 2% today, with kingpin Iomega accounting for 1.5% of the fall.

The stock of Iomega (NYSE: IOM) fell 10% following the announcement that its new Jaz 2GB drives and disks will now ship in the first quarter of 1998 rather than in the current quarter, due to the company's desire to conduct further quality testing of the product. Iomega also announced that it has sold over 11 million Zip drives, which means that Iomega has sold more Zip drives than AOL has members -- and considering the carpet-bombing marketing that AOL has done, that's quite an accomplishment.

With just over one million Jaz drives sold compared to 11 million Zip drives, and with the December quarter nearly over, the news that the new product has been delayed until the first quarter of next year probably isn't worth a 10% decline in the stock. Anyway, we'd rather see the new drives emerge from the factories flawless than have them debut now and have bugs, so Iomega is to be commended for pushing the product back to assure quality (though it's only the company's normal business ethos). The fear, though, is that the product could be delayed beyond one quarter, though there is nothing to substantiate that concern.

At $24 Iomega trades at 19.6 times '98 earnings estimates of $1.22 per share. The company announces fourth quarter results during the final week of January, and the stock splits two-for-one next week. Iomega is splitting the stock in order to make more shares available for granting options to employees.

Next on our Foolish agenda is 3Com (Nasdaq: COMS). After the market closed the company announced earnings of $0.04 per share, well below the previous estimate, but in line with the numbers that management gave on December 2nd. For the quarter, net income was $15.1 million on $1.2 billion in revenue. Sales of systems products (switches, hubs, internetworking and remote access products) totaled $622 million, or 51% of total sales. Client access products (which include network interface cards and modems) were 49% of sales at $599 million. While higher-end product accounted for 51% of sales, it accounts for a much larger percentage of earnings (when the company does have earnings), which is why the world's focus on 3Com as a modem or network interface card company alone is rather short-sighted.

Though that focus isn't shortsighted this quarter because those products caused most of the trouble, with modems moving slowly. The company is now intent on improving its inventory channel practices.

Overall, sales for the quarter were $200 million below those of the same quarter last year, while sales and marketing expenses rose 38% -- not a pretty performance. But the company has $1.1 billion in cash and $41 million in long-term debt -- as strong a balance sheet as ever. Also, accounts receivable declined $300 million, to about $900 million. Finally, inventory is up 50%, though with the company currently instituting a new inventory policy, it's stupid to draw any early conclusions.

3Com can do little about overall market demand except work to take market share from competitors. In the meantime, it continues to focus on its next generation of technology. The stock has been downgraded by everyone and their mom over the past few weeks, and it is now trading below 2 times sales -- and even lower on an enterprise value basis (which considers cash and debt too, both of which are in 3Com's favor). Earnings estimates are currently too much guesswork to cite. The conference call recording for the company can be heard after 7:00 p.m. EST for 24 hours at (303) 267-1037 (code: 258580). We also have more coverage available in a Foolish 3Com earnings collection, available from the Fool mainpage tonight.

Finally, it was worth a good smile to see Amazon.com (Nasdaq: AMZN) decline on the Barnes & Noble (NYSE: BKS) news involving America Online (NYSE: AOL). AOL is currently the cute girl on the block that has every boy lined up for a date, and the company has no intention of turning down any offers. Why should it? America Online is the market place along the Nile of yesteryear, and if you want to sell, you need to pay, and AOL will accept anyone's money. The beauty of cyberspace, of course, is that it's unlimited in space (although, an important distinction: it isn't unlimited in promotional space). AOL now has "exclusive" agreements with both Amazon and Barnes & Noble, and in the future it could sign "exclusive" agreements with any number of other booksellers.

What's more important is how much promotion the booksellers will respectively receive, as opposed to the promotion that can be gotten elsewhere. Amazon, for example, has invaluable promotion coming from Yahoo! (Nadsaq: YHOO). Every time that you complete a Yahoo search, a link to relevant books for sale at Amazon appears. That's "in your face" promotion. With AOL contracts, the promotion that vendors have received in the past has been stale -- a button on the welcome page, but nothing that makes you personally want to click it. There is no value-added promotion there, and most people probably go to their usual online areas without giving the dull welcome page buttons a second thought. That's been my experience in over three years online.

Not that being on the AOL welcome page doesn't increase traffic. At the Fool, we certainly know that it does. But seeing the Barnes & Noble icon on the welcome page has never made me want to click it and buy a book. On the other hand, if I'm doing a search on Yahoo for Egyptian Kings and an Amazon link instantly suggests books on that very topic, suddenly Amazon has my interest. Anyway...

Today Amazon announced that the Barnes & Noble agreement with America Online has no effect on the existing agreement that the company has with AOL. Amazon announced a three-year exclusive bookseller agreement with AOL in July, making Amazon the exclusive bookseller on AOL.com and AOL's NetFind search engine. Amazon has multi-year exclusive bookseller relationships with five of the top six sites on the Web: AOL.com, Yahoo!, Netscape, GeoCities, and Excite. The press release reads:

"'Amazon.com is and continues to be one of AOL's strongest partners,' said Bob Pittman, president and chief executive officer of AOL Networks. 'With the impressive results Amazon.com continues to garner, we feel very strongly about this partnership and are looking forward to working together with Amazon.com in the future and to build on this relationship,' continued Pittman."

AOL, in its position, is going to be dating every company that courts it. And who can blame them? The company is in a sweet spot with 10 million eyes -- err -- 20 million eyes on its service. By the way, AOL announced that online commerce traffic is currently double what it was one year ago.

To end on a positive note: hey! the Fool Four rose 0.79% today, with AT&T hitting a new 52-week high.

Fool on!

--Jeff Fischer


Do your Foolish gift shopping now, barely in time for the Holidays. And consider the Fool's Industry Focus '98 book. Learn which 20 companies in 20 industries our news and analysis team favor most, as they pinpoint what they feel is the best investment in each industry.

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TODAY'S NUMBERS
Stock Change Bid ---------------- AMZN -1 1/16 51.63 AOL - 3/16 83.75 T +1 1/4 59.13 CHV - 13/16 74.06 DJT - 3/16 6.56 GM - 5/8 63.56 INVX - 15/16 20.69 IOM -2 1/2 24.00 KLAC - 1/2 34.25 LU +1 1/16 77.06 MMM +1 85.88 COMS -1 5/16 33.13

Day Month Year History FOOL -2.00% -3.45% 19.80% 219.73% S&P: -1.06% -0.01% 28.97% 108.40% NASDAQ: -1.56% -4.83% 17.98% 111.50% Rec'd # Security In At Now Change 8/5/94 355 AmOnline 7.27 83.75 1051.54% 5/17/95 980 Iomega Cor 2.52 24.00 852.38% 10/1/96 42 LucentTech 47.62 77.06 61.84% 8/12/96 130 AT&T 39.58 59.13 49.39% 8/11/95 125 Chevron 50.28 74.06 47.29% 9/9/97 290 Amazon.com 38.22 51.63 35.07% 8/12/96 110 Minn M&M 65.68 85.88 30.75% 4/30/97 -1170 *Trump* 8.47 6.56 22.51% 8/12/96 280 Gen'l Moto 51.97 63.56 22.30% 8/24/95 130 KLA-Tencor 44.71 34.25 -23.40% 6/26/97 325 Innovex 27.71 20.69 -25.34% 8/13/96 250 3Com Corp. 46.86 33.13 -29.31% Rec'd # Security In At Value Change 8/5/94 355 AmOnline 2581.87 29731.25 $27149.38 5/17/95 980 Iomega Cor 2509.60 23520.00 $21010.40 9/9/97 290 Amazon.com 11084.24 14971.25 $3887.01 8/12/96 280 Gen'l Moto 14552.49 17797.50 $3245.01 8/11/95 125 Chevron 6285.61 9257.81 $2972.20 8/12/96 130 AT&T 5145.11 7686.25 $2541.14 4/30/97 -1170*Trump* -9908.50 -7678.13 $2230.38 8/12/96 110 Minn M&M 7224.44 9446.25 $2221.81 10/1/96 42 LucentTech 1999.88 3236.63 $1236.75 8/24/95 130 KLA-Tencor 5812.49 4452.50 -$1359.99 6/26/97 325 Innovex 9005.62 6723.44 -$2282.18 8/13/96 250 3Com Corp. 11714.99 8281.25 -$3433.74 CASH $32438.81 TOTAL $159864.81








Note
The Fool Portfolio was launched on August 5, 1994, with $50,000. It was renamed the Rule Breaker Portfolio in October 1998. The investing strategy began with the first investments of the Fool Port and has evolved with time and experience. In July 2001, the portfolio began adding $12,500 each quarter (We missed Jan. 2002, so we added $25,000 in April 2002). We skip a quarter if we have enough uninvested cash or cash available in stocks we would prefer to sell to make new investments. All transactions are shared and explained publicly before being made, and returns are compared in each week's column to the S&P 500 (including dividends where noted) and the Nasdaq composite. For a history of all transactions, please click here.